17-May-2023
2 mins read
Options trading is a great strategy to profit from market changes in the Indian stock market. Options trading involves purchasing and selling contracts that allow you the right, but not the responsibility, to purchase or sell an underlying asset at a preset price and time.
One popular options trading strategy in India is the Bull Call Spread. The Bull Call Spread is a popular Indian options trading technique that reduces risk and maximizes earnings. This article explains the Bull Call Spread, how to execute it, and how to apply it in the Indian stock market.
Also Read | What Is Bull Call Spread Strategy? Options Strategy
What Is Bull Call Spread, And How Does It Work?
A Bull Call Spread is an options trading strategy used to profit from a bullish market outlook while minimizing the risk. The strategy includes purchasing a lower-strike call option and selling a higher-strike one.
The premium from selling the higher strike price call option offsets the cost of buying the lower strike price option, resulting in a net negative. The maximum profit is achieved when the underlying asset price rises to the higher strike price, while the maximum loss is limited to the net debit paid.
For example, let’s assume you are bullish on a particular stock trading at Rs 100 and expect it to rise to Rs 110.
You can execute a Bull Call Spread by buying a call option at a strike price of Rs. 100 for Rs 5 and selling a call option at a strike price of Rs 110 for Rs 1.
The net debit paid is Rs 4 (Rs 5 – Rs 1). If the stock price rises to Rs 110 at expiry, the profit would be Rs. 6 (Rs 110 – Rs 100 – Rs 4).
If the stock price remains below Rs 100 at expiry, the maximum loss would be limited to Rs 4.
Advantages Of Using Bull Call Spread
Let’s look at the Bull Call Spread options trading strategy’s benefits now that we understand the basics.
- Limited Risk: The maximum loss is known upfront and is limited to the premium paid for buying the call options.
- Limited Margin Requirement: Unlike buying a call option outright, Bull Call Spread requires lower margin requirements as the sold call option helps offset the cost.
- Profit Potential: Bull Call Spread allows traders to profit from a moderate upward price movement in the underlying asset while limiting the downside risk.
- Higher Probability of Profit: Bull Call Spread can be structured to have a higher probability of profit compared to buying a call option outright.
- Flexibility: Traders can adjust the strike prices and expiration dates to suit their risk appetite and market expectations.
Risks Involved in Using Bull Call Spread
Bull Call Spread is used to take advantage of bullish market conditions. While it has several advantages, some risks are involved in using Bull Call Spread, which investors must be aware of before executing this strategy.
Some of the risks involved in using Bull Call Spread are:
- Limited Profit Potential: The profit potential is limited to the strike prices less the net premium paid for the options. Profits may not cover costs if the stock price doesn’t grow enough.
- Limited Protection: Options net premium is the maximum loss. The Bull Call Spread may not cover losses if the underlying asset price falls sharply.
- Breakeven Point: Before making a profit, you must achieve breakeven. If the asset price doesn’t reach this mark, the trade loses.
- Time Decay: Options have a time value that decays as they approach expiration. As a result, the value of the options used in the Bull Call Spread will decrease over time, which could reduce the potential profit or increase the potential loss.
- Volatility Risk: If the underlying asset price is highly volatile, the Bull Call Spread may not provide adequate protection against price movements, resulting in losses.
Steps to Execute a Bull Call Spread in India Important
Understanding the steps to execute a Bull Call Spread in India is important because it can help traders effectively manage risk and potentially increase profits in options trading.
By following these steps, traders can implement a popular and effective options trading strategy to exploit bullish market conditions.
Step 1: Choose the Underlying Asset
The first step in executing a Bull Call Spread is choosing the underlying asset you want to trade. This can be any asset with options trading available, such as stocks, indices, or commodities.
Step 2: Select the Strike Price
The next step is to select the strike price for the call options you will be trading. In a Bull Call Spread, you will buy a call option with a lower strike price and sell a call option with a higher strike price. The difference between the two strike prices will be your maximum profit potential.
Step 3: Decide on The Expiry Date
After choosing the underlying asset and strike prices, choose the option expiration date. This is the expiration date for options and trade settlement. Choose an expiry date that provides you ample time to earn a profit without making the options overly pricey.
Step 4: Buy Call Option
Next, buy a call option with a lower strike price. If the asset rises, you can buy it at the strike price. Call option buying is called going long.
Step 5: Sell Call Option
Finally, you must sell a call option with a higher strike price. This will give someone else the right to buy the underlying asset at the higher strike price if the asset price goes up. Selling a call option is also known as going short on the option. By selling this call option, you are capping your potential profit and reducing your overall risk. After these procedures, you’ll have conducted a Bull Call Spread. This trade’s profit will be the difference between the call options’ strike prices minus the cost of buying the lower strike price call option.
The potential loss on this trade will be limited to the cost of buying the call option with the lower strike price.
To Sum Up
Bull Call Spread is a popular Indian options trading technique for bullish markets. It involves buying and selling call options with the same expiration date at lower and higher strike prices. This approach lets traders’ profit from a rising asset price while reducing losses. Before adopting this method, traders must understand its risks and benefits.
Also Read | What Is Delta Hedging? Reduce Risk in Options Trading